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STOCKS & BONDS. FOR INDIVIDUALS, GOVERNMENT & CORPORATIONS, CURRENT EXPENSES OFTEN EXCEED THEIR CURRENT INCOMES / REVENUES . . . PEOPLE TAKE OUT LOANS TO ATTEND COLLEGE, BUY HOMES, OR START SMALL BUSINESSES . . . - PowerPoint PPT Presentation

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1STOCKS & BONDSFOR INDIVIDUALS, GOVERNMENT & CORPORATIONS, CURRENT EXPENSES OFTEN EXCEED THEIR CURRENT INCOMES / REVENUES . . .

PEOPLE TAKE OUT LOANS TO ATTEND COLLEGE, BUY HOMES, OR START SMALL BUSINESSES . . .

GOVERNMENTS & BIG BUSINESSES NEED MORE CAPITAL FOR LONGER PERIODS THAN ANY BANK CAN PROVIDE

SELL OWNERSHIP: EQUITY IS THE RIGHT TO COLLECT PROFITS. ISSUING STOCK MORE CAPITAL, BUT OWNERSHIP IS DILUTEDSTOCK = EQUITY = OWNERSHIP

CITIZENSHIP = EQUITY / OWNERSHIP IN GOVERNMENT; KINGS SOLD SHARES (DEMOCRATIZED) TO RAISE FUNDS TO FIGHT WARS (16TH TO 18TH CENTURIES)

SELL DEBT: BONDS EXCHANGE FUTURE CAPITAL FOR CURRENT CAPITALIOU: BUY THIS FOR ME NOW, I WILL PAY YOU BACK LATER

2STOCKS & BONDSSTOCKS PRICES & BOND YIELDS TEND TO BE INVERSELY RELATED WHEN STOCKS GO UP, BONDS GO DOWN

STOCKS 10% CHANCE TO WIN $90BONDS 90% CHANCE TO WIN $10

BONDS = SAFE HAVEN WHEN ECONOMIC CONDITIONS WORSEN & GROWTH PROSPECTS FOR FIRMS LOOKS DIM

STOCKS = GROWTH OPPORTUNITY PREFERRED WHEN COMPANIES EXPAND THEIR MARKET OR PRODUCTS

RATIONAL COMPANIES SHOULD ISSUE STOCKS WHEN THE ECONOMY RISES & BONDS WHEN IT FALLS . . . BUT TEND TO BE PRO-CYCLICAL, NOT COUNTER-CYCLICAL IN FINANCING

3BONDSBOND: PROMISE TO PAY A CERTAIN AMOUNT AT A FIXED POINT IN THE FUTURE A POST-DATED CHECK

GOVERNMENTS / CORPORATIONS AUCTION BONDS TO THE HIGHEST BIDDERLOAN: PRICE = PRINCIPLE + INTEREST RATEBOND: PRICE = PAR VALUE YIELD

BONDS ARE SUPERIOR TO LOANS BECAUSE :1) DEBT SOLD TO MANY DIFFERENT BUYERS (WAR BONDS)

2) THEY CAN BE BOUGHT & SOLD CONTINUOUSLY PRICES RISE & YIELDS DECLINE AS BOND MATURES

4PRICING A BONDISSUER CREDIBILITY: CAN & WILL THE ISSUER OF THE BOND MAKE GOOD ON THEIR PROMISE?

AGENCIES GRADE BONDS FROM AAA HIGHLY RELIABLE TO D DEFAULT OR JUNK BONDS / SIMILAR TO CREDIT SCORESTIME HORIZON UNLIKE INDIVIDUALS, GOVERNMENTS / CORPORATIONS CAN ROLL OVER DEBT IN PERPETUITYSAFEST = US SHORT TERM TREASURY BONDLOWER CREDIBILITY LOWER PRICE HIGHER YIELD

INTEREST RATE: HOW DO BONDS COMPARE TO OTHER SAFE INVESTMENTS?

BOND YIELD > INTEREST RATE BETTER TO BUY BONDSAS INTEREST RATES INCREASE, YIELDS SHOULD INCREASE, DECREASING BOND PRICES

TIME TO MATURITY:

BOND YIELDS NORMALLY DECREASE AS THEY APPROACH MATURITYCOUPONS SOME BONDS INCLUDE COUPONS THAT BEARERS CAN REDEEM FOR MONEY BEFORE MATURITY

5BONDS, SECURITIES & SUB-PRIMEBONDS = FIXED INCOME SECURITY BOND OWNER ENTITLED TO INCOME SECURED BY THE ISSUERS COLLATERAL

GOVERNMENT BONDS TAX REVENUES CORPORATE BONDS CORPORATE ASSETSMORTGAGE BACKED SECURITIES MORTGAGE PAYMENTS

FANNIE MAE & FREDDIE MAC CREATED TO SECURITIZE MORTGAGES INTO COLLATERALIZED DEBT OBLIGATIONS (CDOs) OR MORTGAGE BACKED SECURITIES (MBS)

ISSUER CREDIBILITY RATING AGENCIES OVERRATED CDOs & MBS AS AAA SECURITIES

INTEREST RATE RATES LOW AFTER 9/11, BUT INCREASED AFTERWARD INCREASED YIELDS & REDUCED PRICES

TIME TO MATURITY MBS SLICED & DICED INTO TRANCHES (COUPONS) BY MATURITY / RISK & SOLD TO DIFFERENT BUYERS

***SUB-PRIME / JUNK BONDS SECURE SPECULATIVE***

6NEWTONIAN & BROWNIAN MOTIONNEWTONIANDETERMINISTIC

UNIVERSALITYGENERALITY

F = M x A

CLOCKSMACHINES

RISK ------BONDSBROWNIANPROBABILISTIC

RELATIVITYUNIQUENESS

E = MC2

CLOUDS DNA SNOWFLAKES

UNCERTAINTY -----STOCKS

7STOCKS & BEAUTY CONTESTSSTOCK MARKET = BETS ON PUBLIC OPINIONS GUESS WHAT THE MAJORITY WILL CHOOSE TO WIN A BEAUTY CONTEST

YOU WIN IF . . .

1) YOU BET 2) WHAT THE MAJORITY BELIEVED 3) WHAT THE MAJORITY WOULD PICK 4) AS THE WINNER OF A SUBJECTIVE CONTEST

. . . BUT THE PRICE OF THE BET INCREASES AS MORE PEOPLE MAKE THE SAME BET AS YOU

Ex. BOARD GAME: APPLES TO APPLES

8STOCKS & RANDOM WALKSFOR EVERY STOCK BOUGHT, ONE MUST BE SOLD . . . STOCK PRICE = HALF THINK THE PRICE WILL INCREASE & HALF DECREASE RANDOM COIN FLIP

THEREFORE, STOCK PRICES MOVEMENTS IN A FAIR, COMPETITIVE ARE RANDOM OR UNSYSTEMATIC NOISE

EXPECTED VALUE OF A STOCK MARKET TRANSACTION = ZEROHALF WIN / HALF LOSE

IMPLICATIONS:

ONLY BROKERS (TRANSACTION FEES) & INSIDERS (CHEATERS) CAN PROFIT OVER THE LONG RUN; STOCK MARKET = CASINO A MONKEY THROWING DARTS WILL DO BETTER THAN ANY EXPERT INVESTMENT STRATEGY (BEGINNERS LUCK)PAST NO INDICATOR OF FUTURE SUCCESS; PICKING LOSERS > PICKING WINNERS

9BEATING THE STOCK MARKETFAIR, COMPETITIVE MARKETS NO PROFIT . . . . . . SO HOW DO PEOPLE MAKE MONEY ON WALL STREET?

MONOPOLY / PSYCHOLOGY / INSIDE-INFORMATION / LEVERAGE / RENT-SEEKING / MATHEMATICS / DIVERSIFICATION

MONOPOLY INSTITUTIONAL INVESTORS HEDGE FUNDS, MUTUAL FUNDS & INVESTMENT BANKS HAVE MARKET POWER PRICE MAKERS

LEVERAGE MATHEMATICS IDENTIFIES MARKET FRICTIONS & PROVIDES PRECISE PROBABILITIES EXPLOIT BY LEVERAGE

INTERPERSONAL / INTRAPERSONAL PSYCHOLOGY READ HERD PSYCHOLOGY & CONTROL ANIMAL SPIRITS VALUE INVESTING

PROPRIETARY RESEARCH & STRATEGIES: MARKET RESEARCH & SECRET STRATEGIES

DIVERSIFICATION: BET ON MANY DIFFERENT COIN FLIPS SIMULTANEOUSLY10OPTIONS & FUTURESONE CAN TRADE THE RIGHT TO BUY OR SELL STOCKS, BONDS, OR COMMODITIES CALLED OPTIONS

CALL OPTION: BUY THE RIGHT, BUT NOT THE OBLIGATION, TO PURCHASE AN ASSET AT A CERTAIN PRICE ABOVE PREVAILING PRICE

PROFIT: IF ASSET RISES ABOVE STRIKE PRICE, BUYER POCKETS THE DIFFERENCE, OTHERWISE, LETS OPTION EXPIRE. BULLISH

PUT OPTION: BUY THE RIGHT, BUT NOT THE OBLIGATION, TO SELL AN ASSET AT A CERTAIN PRICE BELOW THE PREVAILING PRICE

PROFIT: IF ASSET FALLS BELOW STRIKE PRICE, BUYER POCKETS THE DIFFERENCE, OTHERWISE, LETS OPTION EXPIRE BEARISH

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